Bond Quotations
•
•
•
•
6-1
Explanatory Notes
For New York and American Bonds
Yield is Current Yield
cv - Convertible bond. cf-Certificates. cld - Called. dc - Deep discount. f Dealt in flat. Il - Italian lire. kd - Danish kroner. m - Matured bonds,
negotiability impaired by maturity. na - No accrual. r - Registered. rp Reduced principal. st - Stamped. t - floating rate. wd - When distributed.
ww - With warrants. x - Ex interest. xw - Without warrants. zr - Zero
coupon.
• vj - In bankruptcy or receivership or being reorganized under the Bankruptcy
Act, or securities assumed by such companies.
• NEW YORK BONDS
• Corporation Bonds
–
CUR
NET
– BONDS
YLD
VOL
CLOSE CHG
– AES Cp 4½ 05 cv
22
33.63 -0.38
– AES Cp 8s 8
17.2
43
46.50 -0.50
– AMR 9s 16
18.0
350
50
-0.63
– ANR 7s 25
8.0
4
88
4.00
Appendix 6A – S&P’s Ratings
•
•
•
•
•
6-2
AAA Debt rated "AAA" has the highest rating assigned by Standard & Poor’s.
Capacity to pay interest and repay principal is extremely strong.
AA Debt rated "AA" has a very strong capacity to pay interest and repay
principal and differs from the higher rated issues only in small degree.
A Debt rated "A" has a strong capacity to pay interest and repay principal
although it is somewhat more susceptible to the adverse affects of changes in
circumstances and economic conditions than debt in higher rated categories.
BBB Debt rated "BBB" is regarded as having an adequate capacity to pay
interest and repay principal. Whereas it normally exhibits adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for debt
in this category than in higher rated categories.
BB, B, CCC, CC, C Debt rated "BB", "B", "CCC", "CC" and "C" is regarded, on
balance, as predominantly speculative with respect to capacity to pay interest
and repay principal in accordance with the terms of the obligation. "BB"
indicates the lowest degree of speculation and "C" the highest degree of
speculation. While such debt will likely have some quality and protective
characteristics, these are outweighed by large uncertainties or major risk
exposures to adverse conditions.
Current Yield of AES Bond
•
• BONDS
• AES Cp 4½ 05
• AES Cp 8s 8
CUR
YLD VOL CLOSE
cv
22
33.63
17.2 43
46.50
• Current Yield Calculation:
•
Price_
=
$465
•
Interest
$80
NET
CHG
-0.38
-0.50
= 17.2%
6-3
Yield to Maturity – ANR Bond for 20 Years
•
• BONDS
CUR
YLD VOL CLOSE
NET
CHG
• ANR 7s 25
8.0
4.00
4
88
6-4
Calculate Yield to Maturity based on assumed 8% discount rate for 20
years:
Table 3-5, 20-year annuity $70 x. 9.8181
= $687.27
Table 3-4, present value: $1,000 x 0.2145 = $214.50
$901.77
Calculate Yield to Maturity based on 8.1%, based on THORNDIKE
ENCYCLOPEDIA OF BANKING & FINANCIAL TABLES:
20-year annuity $70 x. 9.7527
=
$682.69
Discounted present value: $1,000 x 0.2108 =
$210.80
$893.49
Yield Curve
•
•
6-5
Annual Yield (%)
6.25
•
6.00
•
5.75
•
5.50
•
5.25
•
•
5.00
0
5
10
15
20
25
30 Yrs. To Maturity
Stockholder-Bondholder Conflict
6-6
Strategy I – Low Risk:
Firm’s
Expected
Firm
Expected To
Value to
To
Earnings Prob. Value Bondholders Bondholders Stockholders
$6,000
0.1 $600 $6,000
$600
0
$10,000
0.8 $8,000
$8,000
$6,400
$2,000
$14,000
0.1 $1,400 $8,000
$800
$6,000
1.0 $10,000
$7,800
Expected
Value to
Stockholders
0
$1,600
$600
$2,200
Strategy II – High Risk:
Firm’s
Expected
Firm
Expected To
Value to
To
Earnings Prob. Value Bondholders Bondholders Stockholders
$2,000
0.4
$800 $2,000
$800
0
$10,000
0.2 $2,000 $8,000
$1,600
$2,000
$18,000
0.4 $7,200 $8,000
$3,200
$10,000
1.0 $10,000
$5,600
Expected
Value to
Stockholders
0
$400
$4,000
$4,400
Stockholder-Bondholder Conflict
• Choosing Risky Projects (“Asset Substitution”)
• Incurring More Debt (“Claim Dilution”)
• Withdrawal of Shareholder Capital (“Dividend
Payment”)
• Underinvestment
6-7
UV’s Lines of Business, 1977-78
• Federal Pacific Electric Co.:
– 60% of sales
– 81% of profits
– 44% of book value of total assets
– 53% of book value of operating assets
• Oil & Gas Properties:
– 2% of sales
– 6% of operating profits
– 5% of book value of total assets
– 6% of book value of operating assets
• Mueller Brass & Mining Properties:
– 38% of sales
– 13% of profits
– 34% of book value of total assets
– 41% of book value of operating assets
6-8
UV’s Actions
6-9
• Dec. 19, 1978, Board announced plan to sell Federal.
• Jan. 20, 1979, Board announced intent to liquidate UV.
• Mar. 26, 1979, Shareholders approve board plan for a 12-month
liquidation.
• Mar. 29, 1979, UV sold Federal Pacific to Reliance Electric for
$345 million cash.
• April 9, 1979, UV announced an $18 per share initial liquidating
distribution for April 30.
• Trustees objected that liquidating distributions couldn’t occur until
pay-off of all liabilities.
• UV set aside $155 million to cover debentures until a plan of
satisfaction and discharge was reached within 90 days.
• July 23, 1979, UV announced sale of oil & gas properties for $135
million cash to Tenneco, which closed Oct. 2, 1979.
• Nov. 26, 1979, UV agreed to sell Mueller Brass, mining properties,
and $322 million cash to Sharon Steel for $107 million cash plus
$353 million worth of debentures & debt assumption.
Sec. 13.01, First Chase Indenture
6-10
• Nothing in this Indenture or any of the Debentures contained shall
prevent any merger or consolidation of any other corporation or
corporations into or with the Company, or any merger or consolidation of
the Company (either singly or with one or more corporations), into or with
any other corporation, or any sale, lease, transfer or other disposition of
all or substantially all of its property to any corporation lawfully entitled to
acquire the same or prevent successive similar consolidations, mergers,
sales, leases, transfers or other dispositions to which the Company or its
successors or assigns or any subsequent successors or assigns shall be
a party; provided, however, and the Company covenants and agrees,
that any such consolidation or merger of the Company or any such sale,
lease, transfer or other disposition of all or substantially all of its property,
shall be upon the condition that the due and punctual payment of the
principal of, interest and premium, if any, on, all of the Debentures,
according to their tenor, and the due and punctual performance and
observance of all the terms, covenants and conditions of this Indenture
to be kept or performed by the Company shall, by an indenture
supplemental hereto, executed and delivered to the Trustee, be assumed
by any corporation formed by or resulting from any such consolidation or
merger, or to which all or substantially all of the property of the Company
shall have been sold, leased, transferred or otherwise disposed of (such
corporation being herein called the "successor corporation"), . . . .
Travelex Indenture
6-11
Travelex Indenture
6-12
Travelex Indenture
6-13
Travelex Indenture
6-14
Travelex Indenture
6-15
Why Uniformity Trumps Correctness
•
6-16
“Whereas participants in the capital market can adjust their
affairs according to a uniform interpretation, whether it be
correct or not as an initial proposition, the creation of enduring
uncertainties as to the meaning of boiler plate provisions would
decrease the value of all debenture issues and greatly impair
the efficient working of capital markets. Such uncertainties
would vastly increase the risks and, therefore, the costs of
borrowing with no offsetting benefits either in the capital market
or in the administration of justice. Just such uncertainties would
be created if interpretation of boiler plate provisions were
submitted to juries sitting in every judicial district in the nation.”
Basic Property Rights of Creditors in
Indentures
6-17
• “The second fundamental characteristic of long term debt
financing is that the rights of holders of the debt securities are
largely a matter of contract. There is no governing body of
statutory or common law that protects the holder of unsecured
debt securities against harmful acts by the debtor except in the
most extreme situations ... The debt securityholder can do
nothing to protect himself against actions of the borrower which
jeopardize its ability to pay the debt unless he ... establishes
his rights through contractual provisions set forth in the
... indenture.”
The Virtues of Uniformity
6-18
• A large degree of uniformity in the language of debenture
indentures is essential to the effective functioning of the
financial markets: uniformity of the indentures that govern
competing debenture issues is what makes it possible
meaningfully to compare one debenture issue with another,
focusing only on the business provisions of the issue (such as
the interest rate, the maturity date, the redemption and sinking
fund provisions in the conversion rate) and the economic
conditions of the issuer, without being misled by peculiarities in
the underlying instruments.
The Virtues of Uniformity
6-19
• Should strict interpretation apply to negotiated clauses?
• Should parole evidence of discussions between underwriters’
and issuer’s counsel be admissible?
• Should statements made by underwriters about the covenant in
the roadshow?
Covenants
6-20
• Affirmative Covenants:
– pay the debt as scheduled
– Pay taxes
– Maintain assets
– Provide the Indenture Trustee with
required information (as if a reporting
company).
• Negative covenants: Designed to prevent
opportunistic behavior by a debtor that
increases bondholders’ risks.
Restricted Subsidiaries
6-21
Choice between escape from covenants and
benefit of inclusion.
Company (Issuer)
Restricted
Subsidiaries
Unrestricted
Subsidiaries
•Subject to the Covenants
•Not subject to covenants
•Financials included
•Financials not included
•Guarantee the debt (except foreign)
•Treated as third party for transactions
•
•
•
•
Indebtedness
6-22
Ongoing test Quarterly or Annual (usually in
bank debt
Incurrence test
Limit all debt or Senior pari passu or Sub
debt
Limit Security for debt
Indebtedness
6-23
Indebtedness
6-24
Indebtedness
6-25
Indebtedness
6-26
Indebtedness
6-27
Indebtedness
6-28
Indebtedness
6-29
Indebtedness
6-30
Indebtedness
6-31
Indebtedness
6-32
Liens
6-33
Liens
6-34
A Variation on ABF Model Covenants, §10-11
•
6-35
(a) The Company will not . . . incur any Debt . . . that is subordinate
in right of payment to the Notes, if, immediately after giving effect to the
incurrence of such Debt and the application of the proceeds thereof, the
aggregate principal amount of all outstanding Debt of the Company . . .
determined in accordance with GAAP is greater than 60% of the sum of (i)
the Company's Adjusted Total Assets . . .
•
(b) The Company will not . . . incur any Debt if the ratio of
Consolidated Income Available for Debt Service to the Annual Service
Charge on the date on which such additional Debt is to be incurred, on a pro
forma basis, after giving effect to the incurrence of such Debt and to the
application of the proceeds thereof would have been less than 1.5 to 1.
•
(c) The Company will not . . . incur any Debt secured by any
mortgage, lien, charge, pledge, encumbrance or security interest of any
kind . . . ("Secured Debt"), . . . if, immediately after giving effect to the
incurrence of such Secured Debt and the application of the proceeds
thereof, the aggregate principal amount of all outstanding Secured Debt
of the Company . . . is greater than 40% of the sum of (i) the
Company's Adjusted Total Assets . . .
•
(d) The Company will at all time maintain an Unencumbered Total
Asset Value in an amount not less than 150% of the aggregate principal
amount of all outstanding unsecured Debt of the Company . . . .
Variation on Model Covenants, §10-10: Negative Pledge. 6-36
Neither the Company nor any Subsidiary will create, assume or suffer to
exist any Lien on any asset now owned or hereafter acquired by it, except:
•
(a) Liens in favor of the Banks securing the Loans hereunder;
•
(b) Liens for taxes or assessments or other government charges or
levies if not yet due and payable or if due and payable . . . they are being
contested . . . ;
•
(c) Liens imposed by law, such as mechanic's, materialmen's, . . .
Liens, and other similar Liens, securing obligations incurred in the ordinary
course of business which are . . . being contested in good faith by
appropriate proceedings and for which appropriate reserves have been
established;
•
(d) Liens under workmen's compensation, unemployment
insurance, social security or similar legislation;
•
(e) Liens, deposits or pledges to secure the performance of bids,
tenders, contracts . . . or other similar obligations arising in the ordinary
course of business;
•
(f) judgment and other similar Liens arising in connection with court
proceedings; provided that . . . the claims secured thereby are being
actively contested in good faith and by appropriate proceedings; . . . .
•
(j) Liens not otherwise permitted by the foregoing clauses of this
Section securing indebtedness in an aggregate principal amount at any
one time outstanding not to exceed 30% of Consolidated Tangible Net
Worth.
Tangible Net Worth Defined
6-37
• “‘TANGIBLE NET WORTH’ means, as of any date, the
difference of (i) Net Worth, minus (ii) to the extent included in
determining the amount under the foregoing clause (i), the net
book value of goodwill, cost in excess of fair value of net assets
acquired, patents, trademarks, tradenames and copyrights,
treasury stock and all other assets which are deemed intangible
assets under Agreement Accounting Principles.”
LBO Structures
Bidder
100% Owned
Acquisition Sub
(1)
(2)
(3)
(4)
(5)
(6)
6-38
Target Shareholders
Lenders
100% Owned
$
$
Secured Loan
Target Corp.
$ Cash Merger
Target Creditors
Lenders commit to loans at merger closing, on secured and unsecured
basis.
Acquisition Sub merges with Target Corp.
Target shareholders receive proceeds of loan, plus whatever cash bidder
has contributed to Acquisition Sub as equity
Bidder remains sole shareholder of Acquisition Sub.
Surviving Corp. owes all bidder financing to Lenders
Target creditors are subordinated to secured lenders, and equal to
unsecured lenders.
Grades of Credit
6-39
• Investment Grade: Very few covenants;
sometimes no debt incurrence.
• Sub Investment Grade High Yield or Junk Bond:
Large covenant package.
• Cross over Credit: On the border: Springing or
Disappearing Covenants.
MetLife’s Recognition of Claim Dilution Risk in LBOs
6-40
• “Because almost any industrial company is apt to engineer a takeover or be
taken over itself, Business Week says that investors are beginning to view
debt securities of high grade industrial corporations as Wall Street's riskiest
investments. In addition, because public bondholders do not enjoy the
protection of any restrictive covenants, owners of high grade
corporates face substantial losses from takeover situations, if not
immediately, then when the bond market finally adjusts. . . . There have
been 10-15 merger/takeover/LBO situations where, due to the lack of
covenant protection, [MetLife] has had no choice but to remain a
lender to a less creditworthy obligor. . . . The fact that the quality of our
investment portfolio is greater than the other large insurance companies . . .
may indicate that we have negotiated better covenant protection than other
institutions, thus generally being able to require prepayment when situations
become too risky . . . [However,] a problem exists. And because the current
merger craze is not likely to decelerate and because there exist vehicles
to circumvent traditional covenants, the problem will probably continue.
Therefore, perhaps it is time to institute appropriate language designed
to protect Metropolitan from the negative implications of mergers and
takeovers.”
MetLife Memos on Dilution Risk Covenants
•
6-41
“A method of closing this apparent "loophole," thereby
forcing a payout of [MetLife's] holdings, would be through
a covenant dealing with a change in ownership. Such a
covenant is fairly standard in financings with privately-held
companies . . . It provides the lender with an option to end a
particular borrowing relationship via some type of special
redemption .”
•
“Covenants are incorporated into loan documents to ensure
that after a lender makes a loan, the creditworthiness of the
borrower and the lender's ability to reach the borrower's assets
do not deteriorate substantially. Restrictions on the
incurrence of debt, sale of assets, mergers, dividends,
restricted payments and loans and advances to affiliates are
some of the traditional negative covenants that can help
protect lenders in the event their obligors become involved
in undesirable merger/takeover situations.”
MetLife and the Law
6-42
• Boilerplate terms are “strictly construed”
and no parole evidence. (May be different
for a bespoke provision)
• The issuer can do anything not expressly
forbidden by the indenture.
• Quoting Purcell v. Flying Tiger Line, Inc.:
• “The Indenture does not contain any such
limitation [as the one proposed by plaintiff] .
. . . In light of our holding that the indenture
unambiguously permits the transaction at
issue in this case....” - page 374
MetLife and the Law
6-43
• Outside the “zone of insolvency” directors
owe no fiduciary duties to creditors only
contractual duties.
MetLife and the Law
6-44
• P tries two contract theories good faith and
Frustration of Purpose
• Frustration isn’t available where the event
frustrating the purpose was clearly
foreseeable. - page 380
• Critique: LBOs were a financial innovation
that radically changed the leverage in many
corporations. For bonds issued before
1980, this may have been inconceivable.
Change of Control “Put” Provision
•
6-45
In the event that a Change in Control shall occur, each Holder shall
have the right (each, a "CHANGE OF CONTROL REPURCHASE
RIGHT" and, together with the Optional Repurchase Right, each a
"REPURCHASE RIGHT"), at the Holder's option, . . . to require the
Company to repurchase, and upon the exercise of such right the
Company shall repurchase, all of such Holder's CODES not theretofore
called for redemption, . . . on the date (the "CHANGE OF CONTROL
REPURCHASE DATE" and, together with the Optional Repurchase
Date, each a "REPURCHASE DATE") that is a Business Day no earlier
than 30 days nor later than 60 days after the date of the Company Notice
at a purchase price in cash equal to 100% of the principal amount of
the CODES to be repurchased (the "CHANGE OF CONTROL
REPURCHASE PRICE" and, together with the Optional Repurchase
Price, each a "REPURCHASE PRICE"), plus accrued and unpaid
Interest (including Contingent Interest) to, but excluding, the Change of
Control Repurchase Date; provided, however, that installments of
Interest (including Contingent Interest) on CODES whose Stated Maturity
is prior to or on the Change of Control Repurchase Date shall be payable
to the Holders of such CODES, or one or more Predecessor Securities,
registered as such on the relevant Regular Record Date according to
terms and the provisions of Section 2.1 hereof.
Change of Control “Put” Provision
Travelex Definition
6-46
•
Change of Control “Reset” Provision
•
•
•
•
•
6-47
"Adjusted Interest Rate" means, with respect to any Reset
Transaction, the rate per annum that is the arithmetic average of the rates
quoted by two Reference Dealers selected by the Company or its successor
as the rate at which interest on the Securities should accrue so that the
Fair Market Value, expressed in Dollars, of a Security immediately after
the later of:
(1) the public announcement of such Reset Transaction; or
(2) the public announcement of a change in dividend policy in
connection with such Reset Transaction;
will most closely equal the average Trading Price of a Security for the
20 Trading Days preceding the date of public announcement of such
Reset Transaction; provided that the Adjusted Interest Rate shall not be
less than 4.00% per annum. * * *
"Reset Transaction" means: (i) a merger, consolidation or statutory
share exchange to which the entity that is the issuer of the Common Stock
into which the Securities are then convertible is a party, (ii) a sale of all or
substantially all the assets of that entity, (iii) a recapitalization of that
Common Stock or (iv) a distribution described in Section 12.4(d) . . . .
Quick Check Question 6.1
6-48
• If you represented a lender considering a
large loan to Scientific Atlanta (see the
financial statements in Chapter Two), what
types of restrictions on new debt would you
want to see? Do any of the financial ratios
in Appendix 2-B seem promising measures
of the limits you might want to impose?
Variation on Model Covenant §10-11 Limitations on
Additional Funded Debt.
6-49
• The Company shall not, and shall not permit any Subsidiary to, create,
incur, assume or issue, directly or indirectly, or guarantee or in any manner
become, directly or indirectly, liable for or with respect to the payment of any
Indebtedness, except for:
•
(1) Indebtedness under the Debentures and this Indenture;
•
(2) Indebtedness of the Company and any Subsidiary not otherwise
referred to in this Section ____ outstanding on the Date of Issue
(specifically including the full amount available to the Company or its
Subsidiary pursuant to the loan agreements referred to in clauses (i) and (ii)
of the definition of "Senior Indebtedness" contained in Section __ hereof);
•
(3) Indebtedness (plus interest, premium, fees and other obligations
associated therewith), that, immediately [subsequent] to the incurrence
thereof, does not cause the ratio of Funded Debt to Consolidated
Tangible Net Worth plus Shareholder Subordinated Debt to exceed 7:1;
“Funded Debt” Defined
6-50
• “‘Funded Debt’ means any obligation payable more
than one year from the date of determination thereof,
which under GAAP is shown on the balance sheet as
a liability, including obligations under capital leases,
but excluding items customarily reflected below
current liabilities, such as deferred federal taxes on
income and other reserves.”
Scientific Atlanta
Debt/Worth Ratio
(Total Liabilities/Tangible Net Worth)
Total Debt (Liabilities)
Tangible Net Worth (Net worth - intangibles) ($1,508,939 - $81,491)
Thus:
•
$493,889
$1,427,448
6-51
= $493,889
= $1,427,448
= 0.345
MANUFACTURING RADIO & TELEVISION BROADCASTING & COMMUNICATIONS EQUIPMENT SIC# 3663 (NAICS 33422)
Comparative Historical Data
Current Data Sorted By Sales
*
4/1/983/31/99
ALL
90
%
.5
1.3
3.1
4/1/993/31/00
ALL
74
%
.5
1.5
3.0
*
*
4/1/0015 (4/1- 9/30/00) 57 (10/1/00 –3/31/01)
3/31/01
ALL
0-1M 1-3M 3-5M 5-10MM 10-25MM 25MM & OVER
72
NUMBER OF STATEMENTS 3
5
5
20
17
22_________
%
%
%
%
%
%
%
RATIOS
*
*
*
.4 
1.0 DEBT/WORTH
2.2
4.9
2.1
2.1
1.0
.4
1.0
.7
1.2_______
.3 
Thus S-A’s tangible net worth is an infinite number of times its funded debt before
borrowing. If it borrowed $200 million, its funded debt would be approximately 1/7th of
its tangible net worth.
•
Added to its short-term debt, this would mean approximately $700 million debt. Which
would raise its ratio to .5, still well below the median for companies in its business.
• The median for large companies is .7, which would mean S-A could carry total debt of $1
billion, or funded debt of slightly over $500 million and still be at the median.
Variation on Model Covenant 10-11 6-52
• (a)
Debt can’t exceed 60% of
Adjusted Total Assets (a defined term).
• One indenture defines this as follows:
• "Adjusted Total Assets" of a Person as
of any date means the total of all
assets of such Person which would be
shown as assets on a balance sheet of
such Person as of such time prepared
in accordance with GAAP plus
accumulated depreciation.”
Variation on Model Covenant 10-11 6-53
From S-A’s balance sheet (pages 14-15):
Total Liabilities, S-A: $493,889
= 0.246
Total Assets:
$2,002,828
• Thus S-A could increase its debt to as
much as $1.2 billion before violating
such a covenant.
Variation on Model Covenant 10-11 6-54
(b)
Ratio of Income available for debt service (EBITDA) to
Debt Service can’t drop below 1.5 to 1.
• From S-A’s balance sheet:
Net Earnings for 2001:
$333,674
Add back interest expense:
411
Add back dep. and amort.:
66,342
Add back provision for income taxes: 176,728
EBITDA:
$577,155
• S-A’s income statement shows no amortization expense as
a separate entry.
• Thus:
$577,155 = 1404
411
With EBITDA of over $575 million, S-A could support $385 million debt
service.
Variation on Model Covenant 10-11 6-55
(c) Negative covenant that secured debt won’t
exceed 40% of adjusted total assets.
• This would allow $800 million on a $2 billion asset
base. If your client is taking unsecured debt,
that’s a lot of senior debt.
• Since total debt is limited to 60% of total assets,
this is high unless the company has lots of assets
that can be used for such security, such as real
estate.
Variation on Model Covenant 10-11 6-56
(d) Debtor will maintain unencumbered total asset
value not less than 150% of all outstanding
unsecured debt.
• With $2 billion assets, this would allow $1.3 billion
in unsecured debt.
• RMA Annual Statement Studies don’t contain this
ratio.
• But this ratio allows debt to expand to 66.7% of
total assets. One would want to calculate debt
service and interest cost to determine whether this
ratio makes sense.
Travelex Restricted Payments/ Investments
6-57
Travelex Restricted Payments/ Investments
6-58
Travelex Restricted Payments/ Investments
6-59
Travelex Restricted Payments/ Investments
6-60
Travelex Restricted Payments/ Investments
6-61
Model Covenants, §10-16, Investments
6-62
• The Company will not make . . . any loan or advance to any Person or
purchase or otherwise acquire, or permit any such Subsidiary to purchase or
otherwise acquire, any capital stock, assets, obligations or other securities
of, make any capital contribution to, or otherwise invest in, or acquire any
interest in, any Person (all such transactions being herein called
"Investments"), except:
•
•
•
•
•
•
•
(a) Investments in Liquid Assets;
(b) Investments in the Company or any or its Consolidated Subsidiaries;
(c) Investments in accounts, contract rights and general intangibles (as
defined in the Uniform Commercial Code) or notes or other instruments
receivable, arising from the sale, lease or other furnishings of goods or services
by the Company or any Subsidiary in the ordinary course of its business;
(d) Investments in equity interests (including stocks and convertible debt
securities) of corporations which do not become Consolidated Subsidiaries
made with the proceeds of the issuance of stock by the Company;
(e) Acquisitions permitted by Section ___;
(f) Investments (including stocks, equity interests and convertible debt
securities) of corporations that do not become Consolidated Subsidiaries made
with the proceeds of the sale or other disposition of any capitalized Investment
permitted by clause (d), providing the Company gives the Banks notice of such
Investment under this clause; and
(g) additional Investments not exceeding in the aggregate at any one time
outstanding $20,000,000
Prohibiting Substantial Asset Sales
6-63
• “The Company shall not, otherwise than in the
ordinary course of business. sell, lease, transfer, or
otherwise dispose of any substantial part of its
properties and assets, including ... any manufacturing
plant or substantially all properties and assets
constituting the business of a division, branch, or other
unit operation.”
Restrictions on Asset Sales
6-64
• “If the Company in any calendar year and in one or more sales
sells (other than in a sale and leaseback) any fixed assets
acquired prior to [the date of a financial statement preceding
the date of the Indenture] and receives therefore proceeds in
cash or its equivalent amounting in the aggregate to $1,000,000
or more after deducting taxes and expenses applicable to the
sale, such cash or its equivalent shall, within 12 months after
the close of such calendar year, be applied either (a) to the
acquisition by the Company of other property or assets which
are necessary or useful in its business, or (b) to the prepayment
of an equivalent principal amount of Funded Debt of the
Company, in which event such payment shall be prorated
among all Funded Debt of the company at the time outstanding,
including the Debentures.”
Restrictions on Affiliate Transactions
6-65
Restrictions on Affiliate Transactions
6-66
ABF Model Covenants, §10- Waiver of Certain
Covenants
6-67
• Without limiting the rights of the Holders and the Company with
respect to waivers and amendments set forth in Sections
_and , the Company may fail, in any particular instance, to
comply with any covenant or condition set forth in Sections to
, which otherwise does not have a specific waiver provision, if
before or after the time for such compliance the Holders of at
least 66-2/3% in principal amounts of the Debentures
Outstanding shall, by Act of such Holders, either waive such
compliance in such instance or generally waive compliance with
such covenant or condition, but no such waiver shall extend to
or affect such covenant or condition except to the extent so
expressly waived, and, until such waiver shall become effective,
the obligations of the Company and the duties of the Trustee in
respect of any such covenant or condition shall remain in full
force and effect.
ABF Model Covenants, §10- Waiver of Certain
Covenants
6-68
• §316(a)(1)(B) of the Trust Indenture Act permits indentures to authorize
waivers of past defaults on the vote of the holders of not less than a
majority in interest of the indentures.
• Section 5-13 of the Model Covenants provides for waivers of past
defaults on covenants.
• A survey of indentures at the time of the Commentaries (in 1971)
showed the most common percentage was 66b%.
• The Trust Indenture Act provides specific voting rules for some items:
• The indenture can’t be amended to change rights to payment of
interest, unless holders of 75% of debt consent, and interest can’t be
delayed for more than 3 years.
• Any other limits on payment obligations require the consent of the
holder (unanimous consent).
• Because bonds are frequently held in very large blocks by a few
institutional investors , waivers may be feasible in some if not all
cases.
Variation on Model Covenants, §8-1 Company May
Consolidate or Merge Only on Certain Terms 6-69
• The Company shall not consolidate with or merge into any other
corporation or convey, transfer or lease its properties and assets
substantially as an entirety to any Person, and the Company shall not
permit any Person to consolidate with or merge into the Company,
unless:
•
(a) in case the Company shall consolidate with or merge into
another corporation or convey, transfer or lease its properties and assets
substantially as an entirety to any Person, the corporation . . . or into
which the Company is merged or the Person which . . . substantially
as an entirety shall be a corporation organized and existing under the
laws of the United States of America, any State thereof . . . and shall
expressly assume, by an indenture supplemental hereto, executed and
delivered to the Trustee, in form reasonably satisfactory to the Trustee,
the due and punctual payment of the principal of (and premium, if
any) and interest, if any, on all the Outstanding Securities of all series
and the performance of every covenant of this Indenture on the part of
the Company to be performed or observed;
•
(b) immediately after giving effect to such transaction, no
Event of Default, and no event which, after notice or lapse of time or
both, would become an Event of Default, shall have happened and be
continuing;
• *
*
*
ABF Model Covenants, §10-12 Restrictions on Dividends,
Redemptions, etc. – Slide 1
6-70
• (a) The Company will not:
•
(1) declare or pay any dividend or make any other distribution on any
Equity Securities of the Company, except dividends or distributions payable
in Equity Securities of the Company, or
•
(2) purchase, redeem or otherwise acquire or retire for value any Equity
Securities of the Company, . . . or
•
(3) permit a Subsidiary to purchase, redeem or otherwise acquire or
retire for value any Equity Securities of the Company, if, upon giving effect to
such dividend, purchase, redemption or the acquisition, the aggregate
amount expended for all such purposes subsequent to December 31, 1995
would exceed the sum of
(1) 50% of the Consolidated Net Income accumulated subsequent
to December 31, 1995;
•
(2) the aggregate of the net proceeds received by the Company . .
. from the sale or issuance after December 31, 1995 . . . of Equity Securities
of the Company, . . .; and
•
(3) the net proceeds (as above defined) received by the Company
or a Wholly-Owned Subsidiary from the issuance or sale (other than to the
Company or a Subsidiary) of any convertible Indebtedness of the Company
which Indebtedness has been converted into Equity Securities of the
Company after December 31, 1995.
ABF Model Covenants, §10-12 Restrictions on
Dividends, Redemptions, etc. – Slide 2 6-71
•
•
(b) The Company will not (1) declare or pay any dividend or make any
other distribution, other than a Regular Dividend, on any Equity Securities of the
Company, . . . or (2) purchase, redeem or otherwise acquire or retire for value
any Equity Securities of the Company, . . . if, upon giving effect to such
dividend, distribution, purchase, redemption or other acquisition, the
Consolidated Tangible Net Worth of the Company would be reduced to less than
an amount equal to 150% of the aggregate principal amount of Debentures and
all Parity Indebtedness then outstanding.
(c) The provisions of this Section
shall not prevent (1) the payment of
annual year-end bonuses to key employees, executive officers and shareholder
employees of the Company pursuant to the bonus plan described in and
consistent with the restrictions in Section
hereof, (2) the payment of any
dividend within 60 days after the date of declaration thereof, if at such date such
declaration complied with the foregoing provisions, although the dividends so
paid shall be considered in determining subsequent restrictions under this
Section or (3) the acquisition or retirement of any Equity Securities of the
Company by exchange for, or upon conversion of, or out of the proceeds of the
substantially concurrent sale (other than to a Subsidiary) of, other Equity
Securities of the Company, and no effect shall be given to any such acquisition
or retirement or the proceeds of any sale, conversion or exchange in any
computation made under this Section. A certificate of a firm of independent
certified public accountants shall be conclusive evidence of the amount of
accumulated Consolidated Net Income and the amount of Consolidated
Tangible Net Worth.
ABF Model Covenants, §10-5 Maintenance of
Properties
6-72
• The Company will cause all its properties used or useful in the
conduct of its business to be maintained and kept in good
condition, repair and working order and supplied with all
necessary equipment and will cause to be made all necessary
repairs, renewals, replacements, betterments and
improvements thereof, all as in the judgment of the Company
may be necessary so that the business carried on in connection
therewith may be properly and advantageously conducted at all
times; provided, however, that nothing in this Section shall
prevent the Company from discontinuing the operation and
maintenance of any of its properties if such discontinuance is,
in the judgment of the Company, desirable in the conduct of its
business and not disadvantageous in any material respect to
the Debentureholders.
ABF Model Covenants, §10-6 Statement as to
Compliance
6-73
• The Company will deliver to the Trustee, within 90 days after
the end of each fiscal year, a written statement signed by the
President or a Vice President of the Company, stating, as to
each signer thereof, that:
•
•
(1) a review of the activities of the Company during such
year and of performance under this Indenture has been made
under his supervision; and
•
•
(2) to the best of his knowledge, based on such review, the
Company has fulfilled all its obligations under this Indenture
throughout such year, or, if there has been a default in the
fulfillment of any such obligation, specifying each such default
known to him and the nature and status thereof.
ABF Model Covenants, §10-7 Corporate Existence 6-74
• Subject to Article 8, the Company will do or cause to be done all
things necessary to preserve and keep in full force and effect its
corporate existence, rights (charter and statutory) and
franchises; provided, however, that the Company shall not be
required to preserve any right or franchise or any minor
business activity if the Board of Directors shall determine that
the preservation thereof is no longer desirable in the conduct of
the business of the Company and that the loss thereof is not
disadvantageous in any material respect to the
Debentureholders.
ABF Model Covenants, §10-9 Insurance
6-75
• The Company will at all times cause all buildings, plants,
equipment and other insurable properties owned or operated by
it or any Subsidiary to be properly insured and kept insured with
responsible insurance carriers, against loss or damage by fire
and other hazards, to the extent that such properties are
usually insured by corporations owning or operation plants and
properties or a similar character in the same localities;
provided, however, that nothing in this Section shall prevent the
Company or any Subsidiary from maintaining any selfinsurance program covering minor risks if adequate reserves
are maintained in connection with such program.
•
•
•
•
Other Protections
6-76
Convertible Feature (details later)
Helps overcome conflict with an option
on equity
No Call Provision
Call Redemption Premium
Sinking Fund
Redemption Rights
6-77
Redemption Rights
6-78
Sinking Funds
6-79
• Sinking Funds require the debtor to repurchase bonds.
• The greater the leverage of the debtor corporation, the
more likely sinking funds become.
• Brealey & Myers point out several features of sinking
funds:
– Typically debtors can satisfy sinking fund obligations
either by redeeming bonds at par or by purchasing them
in the market.
– When interest rates have fallen the bonds will trade
above par and the corporation will call them for
redemption.
– When interest rates have risen the bonds will trade
below par and the corporation will repurchase them in
the market.
ADM 16% Sinking Fund Debenture Call Premiums
•
•
•
•
•
•
•
•
•
•
•
•
Year
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
Percentage
115.500 %
114.725
113.950
113.175
112.400
111.625
110.850
110.075
109.300
108.525
Year Percentage
1991 107.750 %
1992 106.975
1993 106.200
1994 105.425
1995 104.650
1996 103.875
1997 103.100
1998 102.325
1999 101.550
2000 100.775
and thereafter at 100%
6-80
The ADM Financings
6-81
• May, 1981: $125 million of 16% debentures
• May, 1982: $50.5 million raised with zeroes < 16%
• Jan., 1983: $131 million stock offering
• Mar., 1983: $86 million secured trust receipts (STARS) < 16%
• June, 1983: $$15 million stock offering
• June, 1983: 16% Debentures called.
The ADM Financings
6-82
• Indenture prevents calls “from the proceeds, or in anticipation
of, the issuance of any indebtedness ... if ... the interest cost or
interest factor ... is less than 16.08% per annum.”
ADM Questions
6-83
1. Why were the ADM debentures trading at $1,252.50
when Morgan Stanley bought them on May 5, 1983?
• Interest rates had dropped, so investors would settle
for a lower yield, and pay a premium for these bonds.
2. Can you calculate the current yield on the bonds at
this price?.
Current Yield on ADM 16s
•
•
Interest Payment
Bond Price
$160 .
$1,252.50
= 0.1278
6-84
ADM Questions
6-85
3. What is the call price on these bonds?
ADM Questions
6-86
3. $1,139.50 - above the face value, but
below the current market value.
ADM Quesitons
6-87
4. Why do you suppose Morgan Stanley
bought these bonds at such a premium?
• Morgan is a speculator, and must have
been betting interest rates would go lower
than 12.78%.
• Suppose rates fall to 8%. These were 30
year bonds.
Value of ADM Bonds if Interest Rates = 8%
• Table 3-5 – 30 yr. annuity @ 8%: $160 (11.2578) =
$1,801.25
• Table 3-4 - Discounted for 30 yrs @ 8%: $1,000 (.0994) =
99.40
• Total:
$1,900.65
6-88
ADM Quesitons
6-89
5. What’s the purpose of prohibiting
redemption from the proceeds of a
lower-interest bond issue?
• To preserve some of the benefits of
the bargain of a fixed-rate financing
for the bondholders.
ADM Quesitons
6-90
6. This debenture indenture allowed
redemption on 60 days’ notice
beginning in 1981, with call premiums
starting at 115% of par, and declining
to nearly par in 2000. How can this be
consistent with the prohibition at
issue in this case?
ADM Questions
6-91
6. You can redeem at any time from
other sources of funds, either stock
sales, or perhaps sale of some assets.
This preserves some flexibility for the
issuer, in case it has surplus funds.
ADM Quesitons
6-92
7. Does the market price for the
debentures support Morgan’s
argument that there was a common
understanding that this language
didn’t allow redemption where a
debtor had sold large amounts of new
debt at lower interest rates?
ADM Quesitons
6-93
7. It’s pretty good evidence. Paying $1200 - $1252
for bonds redeemable at $1,139 is evidence that
most investors don’t expect redemption soon.
• There are two possible explanations for this
belief:
– First, investors really did read the language
the way Morgan claims.
– Second, even if ADM could redeem, it might
not. Typically issuers don’t redeem at the
slightest drop in interest rates, but allow
bondholders to get some benefit from their
bargain.
• But ADM wasn’t just anyone – apparently it was
more aggressive in its financing techniques than
some issuers.
ADM Quesitons
6-94
8. How can you tell if the debentures
were being redeemed “from the
proceeds” of any lower cost debt?
ADM had raised $86 million from the
Stars just 90 days before, and $50
million from the zeroes in May 1982?
• The court accepts ADM’s argument,
that if it can show a non-debt source
of funds, then the new borrowings
aren’t the direct or indirect source.
ADM Quesitons
6-95
9. What’s unclear about the redemption
language?
• Not much. Here it is:
ADM Quesitons
6-96
• Indenture prevents calls “from
the proceeds, or in anticipation
of, the issuance of any
indebtedness ... if ... the
interest cost or interest factor
... is less than 16.08% per
annum.”
ADM Quesitons
•
•
6-97
In granting summary judgment to ADM later on,
the court described how hard it would be to find
the “plain meaning” of the indenture language:
“First, there is simply no "plain meaning"
suggested by the redemption language that
would imbue all the contract terms with a
significant meaning. Either party's interpretation
of the redemption language would dilute the
meaning of at least some of the words-- either
the "indirectly or directly," "in anticipation of"
language, were we to adopt defendant's "source"
rule, or the "from the proceeds," "as part of a
refunding operation" language, were we to adopt
the plaintiff's interpretation.” 570 F. Supp. at
1540-41.
ADM Quesitons
6-98
• 10. How can you tell if a redemption
is from the proceeds of a particular
financing? All money is fungible.
• In this case, the court simply requires
that there be some possible
alternative sources, such as the stock
sales.
ADM Questions
6-99
11. The court points to Commentaries
for support for this position. Do they
really support it?
The Commentaries
6-100
• “Instead of an absolute restriction [on redemption], the parties
may agree that the borrower may not redeem with funds
borrowed at an interest rate lower than the interest rate in the
debentures. Such an arrangement recognizes that funds for
redemption may become available from other than borrowing,
but correspondingly recognizes that the debenture holder is
entitled to be protected for a while against redemption if interest
rates fall and the borrower can borrow funds at a lower rate to
pay off the debentures.”
ADM Questions
6-101
12. How does the court find help in the
structure of the redemption provision?
• From the general to the specific:
• The general language permits redemption.
• The specific prohibition only refers to
redemption “from the proceeds” of lower
cost debt.
ADM Questions
6-102
13. Morgan claims it’s not arguing that a
debtor can never redeem when its new
borrowings are at lower rates. What,
exactly, is its argument?
• That the court should look at (1) the size of
the equity financing, apparently compared
to new low-cost debt financing, and (2) the
proximity of these financings to the
redemption.
ADM Questions
6-103
14. Why does the court reject Morgan’s
suggested reading of this clause?
• Because of the uncertainty it would create.
• And uncertainty is worse for bondholders
than ADM’s reading.
ADM Questions
6-104
15. ADM was borrowing at 16% and investing
in risk-free government securities at lower
rates. How could such a strategy make
sense?
• There are two possible answers:
• (1) The court says that perhaps ADM just
invested in Governments “as an interim
holding until such time as ADM decided to
employ such funds for other corporate
purposes.”
• (2) Or ADM could have been involved in
interest rate speculation:
ADM Questions
6-105
• Buy long-term Treasuries & lock in high rates for 20 - 30
years.
• When interest rates drop, refinance the 16% debentures at
rates below the yield on the Treasuries.
• Morgan argues that it’s just a speculation by ADM.
• If ADM buys treasuries with high interest rates and interest
rates drop, it profits from the appreciation.
• And notice that ADM doesn’t have to pay the higher market
price to redeem its debentures - just the call premium.
• The alternative is that ADM was just parking the money
short term while it located investments.
• Given historically high interest rates, this was a terrible
time to be borrowing long term unless you had a wonderful
project right away.
• Parking the money suggests ADM didn’t have such a
project.
ADM Questions
6-106
16. How badly did Morgan Stanley do with its
investment?
• Morgan did pretty badly. It bought
debentures at $1252.50 on May 3, 1983, and
they were called at $1,139.50 on June 1.
• On the other hand, long-term investors who
bought the bonds at the original issue price
($1,000 or close to it) got their promised
interest for two years at 16%, and were then
able to get a call premium of almost 14%.
That’s nearly an extra year’s interest.
• “Instead of an absolute restriction [on
ADM Questions
6-107
16. How badly did Morgan Stanley do with its
investment?
•
Morgan did pretty badly. It bought
debentures at $1252.50 on May 3, 1983, and
they were called at $1,139.50 on June 1.
• On the other hand, long-term investors who
bought the bonds at the original issue price
($1,000 or close to it) got their promised
interest for two years at 16%, and were then
able to get a call premium of almost 14%.
That’s nearly an extra year’s interest.
ADM Questions
6-108
• “Instead of an absolute restriction [on
redemption], the parties may agree that the
borrower may not redeem with funds
borrowed at an interest rate lower than the
interest rate in the debentures. Such an
arrangement recognizes that funds for
redemption may become available from
other than borrowing, but correspondingly
recognizes that the debenture holder is
entitled to be protected for a while against
redemption if interest rates fall and the
borrower can borrow funds at a lower rate to
pay off the debentures.”
What is a Covenant Strip
6-109
• Company makes a tender offer for bonds.
• Condition of tender ist hat immediately before you tender you
consent to an amendment of the indenture that deletes some or
all of the covenants.
• Thus if you don’t tneder and enough to amend provision do you
are left with a gutted indenture.
Katz v. Oak Industries
6-110
• Oak had operating losses of $335 million 1982-85,
leaving negative net worth of $62 million.
• Two Agreements with Allied-Signal:
– To sell its Materials Segment for $160 million cash.
– Allied will purchase $15 million in Oak common stock if
at least 85% of all debt is tendered to exchange offers.
• Two classes of Exchange Offers:
– Holders of 9% convertible notes offered 407 shares of
stock for each $1,000 note. (Stock is trading at $2 - see
n. 2)
– All other classes were offered Cash Payment
Certificates, payable out of proceeds of sale of
Materials Segment.
– All payments below face value but above market value $655 to $918.
Katz v. Oak Industries
• Barriers to Exchange Offers:
6-111
– Covenants prohibit Oak from issuing any debt
obligation in exchange for debentures.
– §4.07 of 13.50% Indenture provides that Oak can’t
acquire any 9% Notes or 11% Notes unless it
concurrrently redeems a proportionate amount of
13.50% Notes.
– Redemption would require payment of redemption price
in indenture rather than lower exchange offer price.
• Solution: Get tendering bondholders to consent to
amendments to eliminate these barriers.
• Further incentive: Get tendering bondholders to
consent to elimination of financial covenants.
• So no rational bondholder would want to remain
holding these weakened bonds.
Katz v. Oak Industries Issues
6-112
1. Does an offer for purposes of benefitting
stockholders constitute a legal wrong?
No.
2. Is an offer “coercive” because it provides
incentives for all bondholders to tender?
No.
3. Does this offer violate the covenant that
Oak won’t vote bonds in its treasury? No.
4. Is Oak’s attempt to force all bondholders
to tender a de facto redemption at prices
below the redemption prices in the
indentures? No
Vote Buying
6-113
Kass v. Eastern Airlines, Inc., 1986 WL 13008 (Del.
Ch. 1986), aff’d, 518 A.2d 583 (Del. 1986) involved a
solicitation by Eastern of its bondholders to relax
certain covenants so it could make a payment to
its shareholders.
• Eastern offered a cash payment or ticket vouchers
to each consenting bondholder.
• Chancellor Allen rejected an argument that vote
buying was against public policy, citing Schreiber
v. Carney, 447 A.2d 17 (Del. Ch. 1982) holding that
buying shareholder votes was unlawful unless
there is a showing of fraud or an attempt to
disenfranchise other shareholders.
•
Amendment
6-114
Vote Buying
6-115
• Chancellor Allen also rejected an argument that
vote-buying wasn’t contemplated by the
bondholders and thus this violates the implied
covenant of good faith & fair dealing.
• “For example, had Eastern not made its offer to all
bondholders on the same terms, but had it
privately paid money to sufficient holders to carry
the election, one would, without more, feel some
confidence in concluding, provisionally at least,
that such conduct was so inconsistent with the
concept of voting implied by the amendment
provision [of the indenture] that it constituted a
violation of what must have been the reasonable
expectation of the contracting parties.”
Trust Indenture Act – 1
6-116
• Applies to all debt issues in excess of $10 million (by exempting
those issued pursuant to an indenture for $10 million or less).
• Mandates use of an indenture for the issuance of debt.
• Indenture contents must be approved by SEC that they meet
requirements of Act.
• Trustees must have capital & surplus of at least $150,000.
• Trustees may not have specified conflicting interests after
default:
– being a trustee under another indenture for the same debtor
– being an underwriter for a debt issue of the same issuer
– owning 10% or more of the debtor’s voting securities
– holding other debt of the debtor that is in default
• Trustee must report to the bondholders annually concerning
any change in its eligibility to serve as trustee, and the amount
owed it by the debtor.
• Limits on the exculpation that may be given the trustee.
Trust Indenture Act – 2
6-117
• Trustee must report to the bondholders annually concerning
any change in its eligibility to serve as trustee, and the amount
owed it by the debtor.
• Limits on the exculpation that may be given the trustee.
• In the event of default, the trustee must notify the bondholders.
– and take such actions as a prudent person would take in the
conduct of his own affairs.
• Regulation of the terms of the indenture concerning
amendment:
– The indenture can’t be amended to change rights to
payment of interest, unless holders of 75% of debt consent,
and interest can’t be delayed for more than 3 years. Any
other limits on payment obligations require the consent of
the holder (unanimous consent).
Trust Indenture Act, Sec. 310(b) -1
6-118
• For the purposes of this subsection, an indenture trustee shall be deemed to
have a conflicting interest if the indenture securities are in default . . . and-•
* (1) such trustee is trustee under another indenture under which any
other securities, or certificates of interest or participation in any other
securities, of an obligor upon the indenture securities are outstanding… * *
*
•
(2) such trustee or any of its directors or executive officers is an
underwriter for an obligor upon the indenture securities;
•
•
•
(3) such trustee directly or indirectly controls or is directly or
indirectly controlled by or is under direct or indirect common control with an
underwriter for an obligor upon the indenture securities;
(4) such trustee or any of its directors or executive officers is a
director, officer, partner, employee, appointee, or representative of an
obligor upon the indenture securities, or of an underwriter (other than the
trustee itself) for such an obligor who is currently engaged in the business of
underwriting, * * *
Trust Indenture Act, Sec. 310(b) – 2
6-119
• For the purposes of this subsection, an indenture trustee shall be deemed to
have a conflicting interest if the indenture securities are in default . . . and—
*
*
*
•
(5) 10 per centum or more of the voting securities of such trustee
is beneficially owned either by an obligor upon the indenture securities or
by any director, partner or executive officer thereof, or 20 per centum or
more of such voting securities is beneficially owned, collectively by any two
or more of such persons; . . .;
(6) such trustee is the beneficial owner of, or holds as collateral
security for an obligation which is in default . . . -•
(A) 5 per centum or more of the voting securities, or 10 per
centum or more of any other class of security, of an obligor, * * *
•
(9) such trustee owns, on the date of default upon the indenture
securities . . . , in the capacity of executor, administrator, testamentary or
inter vivos trustee, guardian, committee or conservator, or in any other
similar capacity, an aggregate of 25 per centum or more of the voting
securities, or of any class of security, of any person, the beneficial ownership
of a specified percentage of which would have constituted a conflicting
interest under paragraph (6), (7), or (8) of this subsection.
Trust Indenture Act, Sec. 310(b) – 3
6-120
• "Except in the case of a default in the payment of the principal of or
interest on any indenture security, or in the payment of any sinking or
purchase fund installment, the indenture trustee shall not be required to
resign as provided by this subsection if such trustee shall have sustained
the burden of proving, on application to the Commission and after
opportunity for hearing thereon, that-•
"(i) the default under the indenture may be cured or waived
during a reasonable period and under the procedures described in such
application, and
•
"(ii) a stay of the trustee's duty to resign will not be inconsistent
with the interests of holders of the indenture securities. The filing of
such an application shall automatically stay the performance of the duty to
resign until the Commission orders otherwise.
•
"Any resignation of an indenture trustee shall become effective only upon
the appointment of a successor trustee and such successor's acceptance of
such an appointment."
TIA § 315 Duties and responsibility of the trustee
6-121
• (a) Duties prior to default. The indenture to be qualified shall
automatically be deemed . . . to provide that, prior to default (as
such term is defined in such indenture)-(1) the indenture trustee shall not be liable except for the
performance of such duties as are specifically set out in such
indenture; and
(2) the indenture trustee may conclusively rely, as to the truth of
the statements and the correctness of the opinions expressed therein,
in the absence of bad faith on the part of such trustee, upon
certificates or opinions conforming to the requirements of the
indenture; . . . .
(b) Notice of defaults. The indenture trustee shall give to the
indenture security holders, . . . notice of all defaults known to the
trustee, . . . Provided, That such indenture shall automatically be
deemed . . . to provide that . . . the trustee shall be protected in
withholding such notice if . . . the trustee in good faith
determine[s] that the withholding of such notice is in the
interests of the indenture security holders.
• (c) Duties of the trustee in case of default. The indenture trustee
shall exercise in case of default . . . use the same degree of care
and skill in their exercise, as a prudent man would exercise or use
under the circumstances in the conduct of his own affairs.
TIA § § 310(b) Default
6-122
• (a) The indenture trustee shall be authorized-–
(1) in the case of a default in payment of the principal of any
indenture security, when and as the same shall become due and
payable, or in the case of a default in payment of the interest on any
such security, when and as the same shall become due and payable and
the continuance of such default for such period as may be prescribed in
such indenture, to recover judgment, in its own name and as trustee of
an express trust, against the obligor upon the indenture securities for the
whole amount of such principal and interest remaining unpaid; and
–
(2) to file such proofs of claim and other papers or documents as
may be necessary or advisable in order to have the claims of such
trustee and of the indenture security holders allowed in any judicial
proceedings relative to the obligor upon the indenture securities, its
creditors, or its property.
• (b) Each paying agent shall hold in trust for the benefit of the indenture
security holders or the indenture trustee all sums held by such paying agent
for the payment of the principal of or interest on the indenture securities, and
shall give to such trustee notice of any default by any obligor upon the
indenture securities in the making of any such payment.
TIA § 317, Special powers of trustee; duties of paying agents
6-123
• (a) The indenture trustee shall be authorized-–
(1) in the case of a default in payment of the principal of any
indenture security, when and as the same shall become due and
payable, or in the case of a default in payment of the interest on any
such security, when and as the same shall become due and payable and
the continuance of such default for such period as may be prescribed in
such indenture, to recover judgment, in its own name and as trustee of
an express trust, against the obligor upon the indenture securities for the
whole amount of such principal and interest remaining unpaid; and
–
(2) to file such proofs of claim and other papers or documents as
may be necessary or advisable in order to have the claims of such
trustee and of the indenture security holders allowed in any judicial
proceedings relative to the obligor upon the indenture securities, its
creditors, or its property.
• (b) Each paying agent shall hold in trust for the benefit of the indenture
security holders or the indenture trustee all sums held by such paying agent
for the payment of the principal of or interest on the indenture securities, and
shall give to such trustee notice of any default by any obligor upon the
indenture securities in the making of any such payment.
•
•
•
•
•
•
Elliot Associates v. Henry Shroder 6-124
Centronics Data Computer Corp. had $40 million of 10%
convertible subordinated debentures outstanding,
convertible into common stock @ $3.25 / share.
§3.01 of the Indenture required 50 day notice of redemption
by Debtor to Trustee unless waived by Trustee.
§3.03 required notice by the Debtor to debenture holders of
at least 15 days but not more than 60 days.
Debentures provided that upon conversion accrued
interest for the semi-annual period was lost.
March 12, 1986, Gordon of Centronics called Sievers of
Schroder to indicate Centronics’ intention to redeem
debentures.
Gordon asked Sievers how much time Schroder would
need once the SEC cleared its registration statement, and
Sievers responded that Schroder would only need one
week.
Elliot Associates v. Henry Shroder
6-125
• March 20, 1986, Centronics’ board approved the
redemption effective May 16, 1986.
• April 4, 1986, Centronics wrote Schroder of its
intent to redeem on May 16, 1986.
• May 1, 1986, SEC cleared the registration
statement, and Centronics gave notice to
debenture holders.
• Centronics disclosed that conversion would yield
more than redemption ($2,038 vs. $1,146).
• And that no interest would be payable on
conversion, while accrued interest would be paid
on redemption on May 16.
• All debentures were converted prior to May 16.
• The interest payment date was June 1.
• Interest lost because of early conversion was $1.2
million.
Elliot Associates v. Henry Shroder Issue 6-126
•Did the Trustee breach
a duty to the debenture
holders in waiving the
50 day notice, which
caused redemption
before the interest was
due? No.
Elliot Associates v. Henry Shroder Issue 6-127
• Centronics literally complied with all the terms of
the indenture.
• The indenture specifically allowed the trustee to
waive 50 days’ notice.
• There is no implied duty to secure greater benefits
for the debenture holders beyond the duties the
Trustee expressly undertook.
• Trust Indenture Act § 315(a)(1) allows a provision
in the indenture that the trustee shall not be liable
except for breach of duties specifically set out in
the indenture.
– Congress rejected a general “prudent man” standard for
the Trustee.
Elliot Associates v. Henry Shroder Issue 6-128
• State common law treats the Trustee’s duties as
creatures of contract.
– The Trustee is a stakeholder with duties defined by
contract.
• ABF Commentaries make clear that this notice is
for the convenience of the Trustee, to give it time
to handle redemptions, so Trustee can waive it.
Bondholders were only entitled to 15 days notice
(Indenture §3.03 )
What is a Default?
6-129
What is effect of a Default?
6-130
What is effect of a Default?
6-131
Global Crossing Indenture, §5.2
•
•
•
6-132
Section 5.2 Collection of Indebtedness by Trustee; Trustee May Prove
Debt.
The Issuer covenants that (a) in case default shall be made in the payment of
any installment of interest on any of the Securities of any series when such
interest shall have become due and payable, and such default shall have
continued for a period of 30 days, or (b) in case default shall be made in the
payment of all or any part of the principal of any of the Securities of any series
when the same shall have become due and payable, whether upon maturity of
the Securities of such series or upon any redemption or by declaration or
otherwise, then upon demand of the Trustee, the Issuer will pay to the Trustee
for the benefit of the Holders of the Securities of such series the whole amount
that then shall have become due and payable ... and in addition thereto, such
further amount as shall be sufficient to cover the costs and expenses of
collection,...
In case the Issuer shall fail forthwith to pay such amounts upon such demand,
the Trustee, in its own name as trustee of an express trust, shall be entitled and
empowered to institute any action or proceedings at law or in equity for the
collection of the sums so due and unpaid, and may prosecute any such action or
proceedings to judgment or final decree, and may enforce any such judgment or
final decree against the Issuer or other obligor upon the Securities and collect in
the manner provided by law out of the property of the Issuer or other obligor
upon the Securities, wherever situated, all the moneys adjudged or decreed to
be payable.
Global Crossing Indenture, §5.4
•
6-133
Section 5.4 Suits for Enforcement.
• In case an Event of Default has occurred, has not been waived
and is continuing, the Trustee may in its discretion proceed to
protect and enforce the rights vested in it by this Indenture by
such appropriate judicial proceedings as the Trustee shall
deem most effectual to protect and enforce any of such rights,
either at law or in equity or in bankruptcy or otherwise, whether
for the specific enforcement of any covenant or agreement
contained in this Indenture or in aid of the exercise of any
power granted in this Indenture or to enforce any other legal or
equitable right vested in the Trustee by this Indenture or by law.
Trust Indenture Act § 316
•
•
•
6-134
(a) The indenture to be qualified –
(1) shall automatically be deemed (unless it is expressly provided therein that
any such provision is excluded) to contain provisions authorizing the holders
of not less than a majority in principal amount of the indenture securities or if
expressly specified in such indenture, of any series of securities at the time
outstanding (A) to direct the time, method and place of conducting any
proceeding for any remedy available to such trustee, under such indenture, or
(B) on behalf of the holders of all such indenture securities, to consent to the
waiver of any past default and its consequences;” * * *
(b)Notwithstanding any other provision of the indenture to be qualified, the right
of any holder of any indenture security to receive payment of the principal
of and interest on such indenture security, on or after the respective due dates
expressed in such indenture security, or to institute suit for the enforcement of
any such payment on or after such respective dates, shall not be impaired or
affected without the consent of such holder, except as to a postponement of an
interest payment consented to as provided in paragraph (2) of subsection (a) of
this section, and except that such indenture may contain provisions limiting or
denying the right of any such holder to institute any such suit, if and to the extent
that the institution or prosecution thereof, or the entry of judgment therein would,
under applicable law, result in the surrender, impairment, waiver or loss of the
lien of such indenture upon any property subject to such lien.
Global Crossing Indenture, §5.7
6-135
• Section 5.7 Unconditional Right of Securityholders to
Institute Certain Suits.
• Notwithstanding any other provision in this Indenture and any
provision of any Security, the right of any Holder of any Security
or Coupon to receive payment of the principal of and interest on
such Security or Coupon on or after the respective due dates
expressed in such Security or Coupon or the applicable
redemption dates provided for in such Security, or to institute
suit for the enforcement of any such payment on or after such
respective dates, shall not be impaired or affected without the
consent of such Holder.
Implied Rights of Action under the Securities Laws
6-136
• Kardon v. National Gypsum Co., (1946) - 10b-5 action implied in tort.
• J. I. Case Co. v. Borak, 377 U.S. 426 (1964) -action implied for proxy fraud
from jurisdictional provision, §28(a).
• Supt. Ins. of N.Y. v. Bankers Life & Cas. Co., 404 U.S. 6 (1971) - 10b-5
liability acknowledged in footnote.
• Cort v. Ash, 422 U.S. 66 (1975) - closer look at (1) protected class; (2)
legislative intent; (3) consistency with purpose of act, and (4) whether a state
remedy existed.
• Touche Ross & Co. v Redington, 442 U.S. 560 (1979) - private right for
false broker filings with SEC rejected under ‘34 Act §17, rejecting Case v.
Borak, questioning Cort v. Ash & emphasizing importance of Congressional
grant of action.
• TransAmerica Mtge Advisers, Inc. v. Lewis, 444 U.S. 11 (1979), rejecting
private right of action under antifraud provisions of Investment Advisers Act
of 1940.
• Merrill Lynch v. Curran, 456 U.S. 353 (1982), 5-4 holding of private right of
action under general antifraud language of Commodities Exchange Act,
holding that Congress approved lower court grants of implied private rights
of action by reenacting the statute w/o change.
Trust Indenture Act §315(d)
6-
137
(d) Responsibility of the trustee. The indenture to be qualified
shall not contain any provisions relieving the indenture trustee
from liability for its own negligent action, its own negligent
failure to act, or its own willful misconduct, except that-(1) such indenture shall automatically be deemed .
. . to contain the provisions authorized by paragraphs (1) and
(2) of subsection (a) of this section;
(2) such indenture shall automatically be deemed .
. . to contain provisions protecting the indenture trustee from
liability for any error of judgment made in good faith by a
responsible officer or officers of such trustee, unless it shall be
proved that such trustee was negligent in ascertaining the
pertinent facts; and
(3) such indenture shall automatically be deemed . .
. to contain provisions protecting the indenture trustee with
respect to any action taken or omitted to be taken by it in
good faith in accordance with the direction of the holders of
not less than a majority in principal amount of the indenture
securities . . . .
TIA § 322(b), ’33 Act §22(a) & ’34 Act § 27
6-
138
• Trust Indenture Act, § 322(b):
• (b) Jurisdiction of offenses and suits. Jurisdiction of offenses and
violations under, and jurisdiction and venue of suits and actions
brought to enforce any liability or duty created by, this title, or any
rules or regulations or orders prescribed under the authority thereof,
shall be as provided in section 22(a) of the Securities Act of 1933.
• Amendments: 1990. Act Nov. 15, 1990, in subsec. (b), inserted "or
duty".
• Securities Act, § 22(a):
• The district courts … shall have jurisdiction of offenses and violations
under this subchapter … of all suits in equity and actions at law
brought to enforce any liability or duty created by this subchapter.
• Securities Exchange Act, § 27:
• “. . . the district courts ... shall have exclusive jurisdiction of violations
of this title ...and of all suits in equity and actions at law brought to
enforce any liability or duty created by this title...."
Capitalized Leases
6-139
• Operating Lease: Company expenses
rentals as and when paid but shows not
liability (note SEC is requiring disclosure of
Commitments and Contingencies in MD&A.
• Capitalized Lease is like buying an asset
with secured debt financing. Legal, tax and
accounting treatment not always
consistent.
• Cap Lease asset comes on balance sheet
as well as the PV of lease obligations.
Interest element is expensed each year.
Securitization
6-140
• May make borrowing available on better terms
for some borrowers.
• General Credit Rating low but if SPE is
bankruptcy remote rating on the securitized asset
is higher.
Pre- and Post Borrowing Balance Sheets
• Original Balance Sheet
•
Assets
– Cash
– Receivables
– Plant & Equipment
–
– Total Assets
• Current ratio:
2:1
Liabilities & S/H Equity
$100 Current liabilities
$100 Long-term liabilities
$200 Total liabilities
Shareholders’ Equity
$400 Total Liabilities + Equity
Debt-equity ratio:
1:1
• Balance Sheet with Borrowing
•
Assets
– Cash
$200
– Receivables
$100
– Plant & Equipment
$200
–
– Total Assets
$500
• Current ratio:
3:2
Liabilities & S/H Equity
Current liabilities
Long-term liabilities
Total liabilities
Shareholders’ Equity
Total Liabilities + Equity
Debt-equity ratio:
3:2
6-141
$100
$100
$200
$200
$400
$200
$100
$300
$200
$500
Balance Sheet with Sale
•
•
Assets
6-142
• Total Assets
Liabilities & S/H Equity
$200 Current liabilities
$100
0 Long-term liabilities
$100
$200 Total liabilities
$200
Shareholders’ Equity
$200
$400 Total Liabilities + Equity $400
• Current ratio:
• Debt-equity ratio:
2:1
1:1
Cash
Receivables
Plant & Equipment